Revenue-Recognition Rules: From the Many, One?

Coming this fall, a sneak peek at a slimmed-down revenue recognition rule. Software companies and other interested parties: Here's your chance to make some noise about it.Marie Leone, CFO.com | USJuly 17, 2008

E pluribus unum is the rally cry behind the newest push by the Financial Accounting Standards Board to rewrite revenue recognition rules and guidance. At Wednesday's board meeting, the five-member panel decided to publish a discussion paper that will cover key concepts regarding revenue recognition — notably, the possibility of boiling down the myriad industry-specific rules into a single general standard.

The discussion paper, expected to be released in October or November, will also provide some of the board's preliminary thoughts on contract value measurement, as well as circumstances that would require companies to remeasure a contract's performance obligations. A performance obligation is the services or products promised in a contract that have not yet been delivered to a customer. From a revenue-recognition perspective, that includes an airline ticket that has been purchased in advanced, but not yet used, or remaining time left on a software license subscription. Indeed, traditionally the software industry has been plagued with thorny revenue recognition issues centered around when to book revenue.

To be released to the public as a way of soliciting early-stage opinions, the discussion paper will likely have a four-to-six-month comment period. The more detailed — and vetted — exposure draft is slated to be issued in October 2009, with the final rule expected to be implemented by mid-2011.

While many of the concepts in the discussion paper will be familiar to preparers, users, and auditors of financial statements, some overarching concepts may portend what FASB chairman Robert Herz called "big" changes. He noted that as revenue concepts are addressed, associated cost issues will likely be tackled, too. That includes FASB's tentative conclusion to disallow the deferral of some costs in favor of recording them as an expense as incurred. A revision like that would certainly change reported income for most companies. As a result, Herz emphasized that the discussion paper on revenue recognition should address the potential change, as a way of allowing constituents to scrutinize the concept.

Trimming down the existing revenue recognition rules was the main topic of debate, however. Currently, there are at least 25 different industry-specific rules contained within U.S. accounting literature pertaining to revenue recognition, including separate mandates for airlines, casinos, the film business, mortgage banks, hospitals, and software companies. Under current rules, each industry named by FASB applies different revenue-recognition rules dictated by circumstances peculiar to that sector.

For instance, in the film business, a movie studio recognizes revenue from a licensing contract with a distributor only after it meets five specific conditions. That includes when "the license period of the arrangement has begun and the customer [distributor] can begin its exploitation, exhibition, or sale." Construction-industry rules are particularly complicated. From the outset, contractors must choose between two policies related to the timing and criteria for revenue recognition — one is a percentage-of-completion method; the other a straight completed-contract method. In other construction cases, contracts that are negotiated as a package, such as an agreement to both supply and install an elevator system, have their own set of revenue-recognition criteria.

FASB's overarching goal for the next year is to whittle down the current rules into a single standard, and to have it mesh with international accounting rules. To date, basic concepts remain in place. For example, a contract can be carried as either an asset or liability on a company's book. It is an asset if the value of the remaining work to be done or product to be delivered exceeds the remaining rights or payments to be collected. Further, the discussion paper will reiterate that revenue is recognized when a performance obligation is satisfied, not when the contract is obtained.

However, the discussion paper will include some major changes to how revenue is reported, particularly with regard to how a single standard applies to construction-type contracts that involve a work-in-progress (WIP). In such cases, the assets are transferred to the customer on an ongoing basis as a continuous sale. Currently, the revenue-recognition principle is tied to the value of the WIP. But the proposed model would link recognition to a different asset, the contract.

FASB acknowledges that other industries may have similar issues with moving to a single general standard, and expects those constituents to file comments with the board regarding what kind of problems their new ideas might cause.

The proposed measurement provisions will have varying affects on corporate accounting. From a broad perspective, most industries will be affected by FASB's decision to use the so-called customer consideration measurement approach, rather than the fair value approach, when measuring contractual assets and liabilities. In the customer consideration approach, the value of the rights — or payments — is measured at the price promised by the customer when the contract is inked. This amount is allocated to the performance obligations on a pro-rata basis.

Regarding remeasuring performance obligations, FASB thinks the value should be locked in at the contract's inception, and not updated unless the contract becomes "onerous." The board has not yet decided when a contract becomes onerous, however.

More narrowly focused is the discussion paper's thinking on breaking up contract parts into separate accounting units. That is usually an issue for companies that use contracts containing "multiple deliverables," as well as some software agreements. In both types of contracts, before a company can treat each service or product as a separate accounting unit, it must provide objective pricing data for the asset or liability, which usually means a vendor price. The new proposal, however, requires the use of estimated stand-alone prices for the assets if no observable selling prices for those assets and liabilities exist.